Investment Outlook

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November 01, 2019

Investment Outlook

Tom Elliott

Market sentiment: Not afraid at Halloween. After a bad start to October, global stock markets have had a good second half to the month.

Market sentiment: Not afraid at Halloween. After a bad start to October, global stock markets have had a good second half to the month. The U.S Fed has just delivered on its hints of a further 25bp interest rate cut. This helped suppress short term Treasury yields relative to the 10 year, and there is no longer an inversion in the U.S yield curve. Both China and the U.S claim progress is being made on trade talks. The risk of no-deal Brexit on 31st October slowly evaporated amongst some complicated politicking at Westminster. In the eurozone, the surprisingly robust French economy has emerged as a possible counterweight to weakness in Germany. 

This does not mean fears of an overvalued U.S stock market are not off the table (how can the S&P500 be reaching new highs while 3rd quarter earnings are forecasted to be down 9% over the year?). And many investors think that a cyclical slowdown in global growth is overdue. But, for now, the current mood music is positive.

The MSCI World Index was up 2.7% in USD at yesterday’s close, and up 2.2% in local currency. However, the U.K and other sterling-based investors have suffered a fall of 1.7% in the same index, reflecting sterling’s appreciation in October as the risk of a chaotic no-deal Brexit subsidised. 

Will sterling rally as the Brexit fog clears?

Sterling may well remain in a fairly tight range around today’s $1.30 over the course of the election campaign. Little Brexit-related news is expected during the period. FX traders will wait to see what emerges from this very unpredictable election, not making any big bets until the results are in. And even when the results are in, they may still be on pause, since sterling is likely to face a new set of risks depending on whether a Conservative or Labour-led government emerges.

Certainly Brexit part one (being the exiting from the E.U) is slowly gaining clarity. Thankfully, the most damaging outcome -a no-deal Brexit on 31st January or 31 December 2020- is now quite small. And the Conservative party has a Brexit plan, which has begun its passage through the House of Commons, although it is now on hold until the 12th December election is over. 

The end game appears to be either 1) a new House of Commons voting for the government’s existing Brexit deal with the E.U, if the Tories win a majority, or if they lead a coalition government with the Brexit party.
2) A second referendum, with two options. One is that Theresa May or Boris Johnson’s deal is accepted, but with the significant amendment whereby the U.K remains in the customs union. The other choice on the ballot paper will be to revoke Article 50, and the U.K remains in the E.U. This second referendum may happen if a coalition government of Labour and LibDem/ SNP / others wins power. 

Both a Johnson and a Corbyn-led government represent new uncertainties for sterling

If Boris’ deal is passed by Parliament in the month following an election, the government will have a lot of wrangling with the E.U still to do on securing a free trade agreement and agreeing on security issues. This, together with building new trade alliances with third countries, is part two of Brexit. And the overall impact on leaving the E.U is very likely to curb GDP growth over the coming decade. The problem of the union with Northern Ireland and Scotland will continue to unsettle politics. These issues will impact negatively on U.K corporate earnings, sterling and bond prices. 

If a Corbyn-led Labour party government wins power, or coalition government in which Labour has the whip hand, a new set of problems will hit sterling. The Labour party’s economic policies are akin to those of Michael Foot and Tony Benn. Investor relief at any softening of Brexit through remaining in the customs union, or an abandoning of Brexit, will be countered by the prospect of 1970s socialism making a comeback. 

Sterling will rally most if the LibDems are able to dominate a coalition government and secure revocation of Article 50 without the promise of 1970s style socialism. But this appears unlikely.

Long-term investors and short-term FX trades

A long term stock market investor (say with a 10yr horizon) shouldn’t be investing in expectations of near-term FX moves as a point of principle. Instead, they should focus on the combination of valuation and growth prospects. And with a firm eye on long term risk/ return data from the asset classes. Remember, historically long term investors have made more of their total return from the effect of reinvesting dividends than from the rise in the value of the underlying shares. 

U.K equities short term view

Global investors are becoming more favourable towards UK equities, as an outcome to Brexit, part one appears closer. They may be jumping the gun, given the observations above. However when influential investors, such as the hedge fund Lansdowne, announces that it sees UK equities as offering significant opportunity, given depressed valuations, one tends to listen. 

Investors are differentiating between UK-focused businesses, such as insurers, utilities, and retail, and those FTSE 100 multinationals that have a relatively small exposure to the UK economy, such as miners, oils, pharmaceuticals. If one wants exposure to a relief rally that may happen when Brexit part one is completed, and even more so if it is softened or abandoned, the former will probably outperform. Large foreign currency-earning companies may even see a rise in sterling depress their GBP share price. But beware of the subsequent retreat of sterling and U.K assets as the magnitude of the task of agreeing on Brexit part two sets in, or as Corbyn announces a socialist paradise will be built in Britain. 

Investors can help protect themselves from market uncertainty through exposure to a broad range of assets, currencies and geographic regions. The mantra of an investor should always be ‘diversification’ – this is especially pertinent in today’s uncertain market conditions. Many long term investors favour investing in a combination of global equities and bonds since the two asset classes have a relatively low correlation with each other and so offer diversification benefits. 

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